Should you buy TCS shares after warning over Q2 earnings?

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Updated: September 9, 2016 12:07:59 PM

Tata Consultancy Services (TCS) on Thursday announced that it is witnessing a sequential loss of momentum in its key banking, financial services & insurance (BFSI) vertical, citing lower discretionary spending in the vertical, particularly in USA.

TCS shares, Tata consultancy servicesTata Consultancy Services (TCS) on Thursday announced that it is witnessing a sequential loss of momentum in its key banking, financial services & insurance (BFSI) vertical, citing lower discretionary spending in the vertical, particularly in USA. (Reuters)

Tata Consultancy Services (TCS) on Thursday announced that it is witnessing a sequential loss of momentum in its key banking, financial services & insurance (BFSI) vertical, citing lower discretionary spending in the vertical, particularly in USA. Reacting on the announcement shares of the IT major plunged over 5 per cent on Thursday. On September 9, shares of the company were trading marginally in green in the late morning trade. At 11.47 am, TCS was trading 0.94 per cent up at Rs 2342.90. The scrip opened the day at Rs 2325 and has touched a high and low of Rs 2357.20 and Rs 2320, respectively, in trade so far.

Based on August 2016 data, the company said that its clients in the BFSI vertical are indicating abundant caution on their business outlook. BFSI is the largest revenue generating vertical for TCS, accounting for around 40 per cent of the company’s total revenue. TCS has refrained from issuing any guidance on its revenue growth as well as margins, but it has indicated that it will update investors on business trends in Q2FY2017 results.

Sharekhan in a research report said, “We have tweaked our revenue estimates for FY2017E and FY2018E due to cautious management commentary on the demand outlook and macro overhang (relating to Brexit). We continue to maintain our cautious stance on the IT sector and expect further volatility in earnings performance across IT companies. On a longer term basis, we still prefer TCS, owing to its diversified portfolio and headstart in the Digital space. However, in the near to medium term, we expect the stock to underperform. At the current level, the stock trades at 17.4x and 15.8x FY2017E and FY2018E estimates, respectively. We have downgraded our rating to ‘Hold’ with a revised target price of Rs 2,450.”

The IT major had outperformed its peer in the previous quarter ended June 30, 2016, however, the cautious view indicates that it will post lower revenue growth on a sequential basis in the quarter ending September 2016. For the quarter ended June 30, 2016, the company reported a consolidated net profit of Rs 6317 crore, down 1.50 per cent, against Rs 6413.12 crore in the sequential quarter ended March 31, 2016.

According to a brokerage firm Sharekhan, macro headwinds (relating to Brexit), coupled with cross currency impact on revenue in Q2FY2017 could cast a shadow on its overall FY2017 revenue performance. Q2FY2017 is a seasonally strong quarter for the IT sector and H2FY2017 is usually the weaker half. Therefore, the brokerage house feel that it will be very tough for TCS to post revenue growth beyond 8-9 per cent in FY2017. Also, TCS will miss the target margin band of 26-28 per cent for FY2017 on account of lower revenue growth, cross currency headwinds and absence of rupee benefits in Q2FY2017. Thus, Sharekhan believes that it will be an uphill task for TCS to maintain its margin range of 26-28 per cent in FY2017.

However, Religare Institutional Research in a report said, “We have maintained that the growth differential between larger peers has narrowed down and TCS’s earnings expectations remain high. Hence, we think valuations at 17x F18E PE are not justified. We also expect valuations for TCS to converge with other large players (particularly with Infosys) given the high BFSI concentration risk and potential earnings downgrades for TCS. We maintain ‘Sell’ on TCS shares with target price of Rs 2,300.”

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